The future looks bright for the next generation of retirees – we're living longer, with the number of
So, what does that mean about the way we fund retirement? With more life to look forward to and more passions to pursue, it's essential that we build a nest egg that lasts a lifetime. Annuities can help you protect what matters to you as you work toward living a long and fulfilling life in retirement.
What are annuities?
An annuity is a contract between you and an insurer that guarantees lifetime income in retirement. You can pay a lump sum or a series of premium payments to the insurer, and in turn they provide income payments to you in retirement. When you begin to receive those payments depends on when you plan to retire and the type of annuity you purchase.
Annuities can be a great addition to your retirement income plan, as they are one of the few investment solutions that can ensure you won't outlive your money. You can also enjoy the simplicity of regular payments – once you choose the type of annuity that's right for you, you can receive your payments based on the terms in your contract without any additional effort.
There are two stages to any annuity contract. The first stage is the accumulation stage, or the period where you save and potentially grow your retirement funds and build the cash value of your annuity. This phase ends at the onset of the distribution stage, when you're ready to begin spending the money to create an income in retirement. With annuities, this is called annuitization – or the process of converting your annuity into regular payments for retirement.
How you build your retirement funds and cash value (accumulation) and then convert those funds into guaranteed income (distribution) will depend on the type of annuity you purchase.
The 4 types of annuities
- When you begin receiving payments – You can either receive your annuity payments immediately after paying the insurer a lump sum (immediate) or receive monthly payments in the future (deferred).
- How your annuity investment grows – Annuities can grow in a couple different ways – through interest rates (fixed) and by investing your contributions in the market (variable).
Immediate annuities: The lifetime guaranteed option
One of the trickier elements in retirement income planning is figuring out how long you're going to live. Immediate annuities are designed specifically to provide an immediate guaranteed lifetime payout.
The drawback is that you're trading liquidity for guaranteed income – so you generally won't have access to that full lump sum if you need it for emergencies. But if securing lifetime income is your top concern, then a lifetime immediate annuity could be the right option for you.
What makes immediate annuities so appealing is that the fees are woven into the payout – you contribute a certain amount of money, and you know exactly how much money you will be receiving for the future, for the rest of your life and your spouse's life.
Financial organizations like Thrivent that offer immediate annuities typically offer additional income payout options, like recurring payments over a fixed term, or until you die. You may also have an optional death benefit, where you can have payments sent to people and causes of your choosing.
Deferred annuities: The tax-deferred option
Deferred annuities provide guaranteed income in the form of a lump sum or monthly income payments on a date in the future. You pay a lump sum or monthly premiums to the insurer, who will then invest them into the growth type you agreed on – fixed, variable or index (we'll get to those in a minute). Depending on the investment type you choose, deferred annuities offer potential for the principal to grow before receiving payments.
Deferred annuities are a great option if you want to contribute your retirement income on a tax-deferred basis – meaning you won't have to pay taxes until you take money out. Unlike IRAs and 401(k)s, there are no contribution limits.
Fixed annuities: The lower-risk option
Fixed annuities are the simplest type of annuity to understand. The insurance company gives you a guaranteed fixed interest rate on your investment when you agree to a length of your guarantee period. That interest rate could last anywhere between a year and the full-length of your guarantee period.
When your contract is over, you can either annuitize your contract, renew your contract, or transfer your money into another annuity contract or retirement account.
Because fixed annuities are based off the guaranteed
Variable annuities: The highest upside option
Like mutual funds, sub-accounts are dependent on market risk and performance. Fortunately, variable annuities also come with a death benefit, an income rider that your beneficiaries are guaranteed income, too. Additionally, Thrivent's guaranteed lifetime withdrawal benefit helps protects against longevity risk and market risk. The double protection can be very appealing if you are 15 years or less to retirement.
A variable annuity can be a great addition to your retirement income plan if you've already maxed out your Roth IRA or 401(k) contributions and would like the comfort and confidence of guaranteed income – so you can focus on your goals knowing you won't outlive your money.
The pros & cons of the types of annuities
Provide a fixed interest rate on your investment for a set period
Provide growth potential of the market through sub-accounts
Pay a lump sum and receive guaranteed income right away
Type 1: Immediate Fixed
Pros: Receive income right away, simplicity of not needing to monitor investment, know exactly how much money you'll receive in payout
Cons: Payments can end upon the death of the annuitant; may not keep pace with inflation; trading liquidity for guaranteed income
Type 2: Immediate Variable
Pros: Guaranteed lifetime income right away, opportunity to benefit from the market, death benefit for beneficiaries
Cons: Less common and can be more expensive than other retirement options; monthly payments may fluctuate based on the market
Pay a lump sum or income premiums to receive guaranteed income at a set future date
Type 3: Deferred Fixed
Pros: Easier to understand; principal protection; payment timing flexibility; tax-deferred growth during accumulation phase; No annual contribution limits; Not impacted by market volatility
Cons: Subject to early-withdrawal penalties; may not keep pace with inflation
Type 4: Deferred Variable
Pros: Tax-deferred growth during accumulation phase; potential to benefit from the upside of the market
Cons: Subject to early-withdrawal penalties; assets subject to market fluctuation
Are annuities right for you?
No one should live in fear of outliving your hard-earned nest egg. Annuities can offer that sense of income confidence and with a closer look at your goals and values, a financial advisor can help you decide which type of annuity makes sense for you.
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